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What is Libor?

LIBOR, also known as the London Interbank Offered Rate, is the most active interest rate market in the world. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. LIBOR is used in determining the price of many other financial derivatives, including interest rate futures, swaps and Eurodollars. With London's importance as a global financial center, LIBOR applies not only to the Pound Sterling, but also to other major currencies such as the US Dollar, Swiss Franc, Japanese Yen and Canadian Dollar.

Every morning at 11:00am London time, LIBOR opens. A department of the British Bankers Association averages the inter-bank interest rates being offered by its members. LIBOR is calculated for periods as short as overnight and as long as one year. While the rates banks offer each other vary continuously throughout the day, LIBOR is fixed for the full 24 hour period. Generally, the difference between the instantaneous rate and LIBOR is very small, especially for short-term rates.

Interest rate swaps are another significant financial derivative dependent on LIBOR. In an interest rate swap, two parties exchange sets of interest payments on a given amount of capital. Generally, one party will have a fixed interest payment, while the other will have a variable rate. The variable rate payment stream is often defined in terms of LIBOR. Interest rate swaps, and by extension LIBOR, are extremely important in providing a liquid secondary market for residential mortgages, which in turn allows lower interest rates on US mortgages.